I have and it didn’t really answer my question. I was specifically asking about your “not drawing SS” as a prerequisite to doing Roth conversions. Why?
Ah, sorry to misunderstand.
The difference between drawing or not drawing SS is simply that for people who have enough lifetime income and assets to make worrying about this RMD reduction stuff worthwhile, their taxable income without SS (or a taxable pension) is very small. Meaning they have a lot of headroom to make taxable Roth conversions at the lowest marginal tax rates.
OTOH, someone who is drawing social security, or has a comfortable taxable pension, already has a bunch of taxable income. Meaning the lowest marginal tax brackets that have the greatest tax-savings possibility are already full of income from that SS or pension. Leaving much less headroom to make the taxable Roth conversions before you push yourself into the higher brackets.
Using myself as an example since I’m in a very simple place where IMO the decision is easy and obvious:
My wife and I both turned 65 and retired late in 2023. Both with a long history of SS-max incomes. Due to small pensions and large savings arranged extremely tax efficiently, we expect to have a 2024 taxable income of something around $zero net of the standard deduction. Of course our spending will greatly exceed our taxable income, but that’s the ideal of every retiree: spending without taxes. Meanwhile we expect our non-taxable income and non-taxable asset growth to outpace our spending. So no work, no taxes, and richer next year even after spending. The American Dream. Shame there’s so much luck involved and so few Americans get to live it. Anyhow back to business …
For 2024 for married people the 10% bracket covers the bottom ~$25K, then 12% up to ~$95K then 22% up to ~$200K, then 24% up to $385K.
Which means we could do a voluntary Roth conversion of say, $95K, and pay (10% of 25K) + (12% of (95-25K) = 70K) = 2,500 + 8,400 = $10,900 in voluntary taxes.
Now lets pretend we start drawing both our social securities instead. Now we take in two people times ~$35K each = $70K Of which at that income level 85% is taxable. Now our taxable income before we do any conversions is (85% times $70K) = 59,500 higher than it was before. Let’s still assume our taxable investment income exactly offset the standard deduction as we’d assumed before. So our actual taxable income is $59,500. Call it $60K for simplicity.
So now any voluntary conversion Roth looks very different from the first scenario. We already used up the entire 10% tax bracket with our SS income . And 2/3rds of the 12% bracket too. Only (95-60)=35K of any Roth conversion we’d make is taxed at 12%. Any larger conversion is taxed next at 22% and, if large enough, 24%.
Here comes the punchline:
So if I insist (quite reasonably IMO) that 12% is the highest tax rate I’m willing to pay on a voluntary Roth conversion to make it worth my while considering time value of money, future tax rate uncertainties, etc. … My conclusion is:
- Without taking SS I can profitably convert $95K per year.
- With taking SS I can profitably convert only $35K per year.
Big difference.
The same logic of course applies to larger numbers in the higher brackets. If you (any you) have a truly mongo IRA/401K your RMDs will already be taxed in the 32% or 35% bracket. In which case getting that “on sale” by converting early while paying those taxes in the 24% bracket will look like a relative bargain.
OTOH, if your RMDs for the size of your accounts will put you in the 22 or 24% bracket, then withdrawing what you can while staying in the 10% & 12% brackets makes clear sense, while converting more such that you’re paying taxes on some of it in the 22% or certainly 24% rate bracket makes no sense at all. That’d be paying almost the same taxes as later, but doing it years early to no or negative benefit.
But … and this circles back to the OP …
If for whatever reason you think tax rates will be materially higher and tax brackets materially smaller even in the lower brackets 5 or 10 years from now, you can in effect “lock in” today’s (supposedly) low tax rates on your IRA/401K, by doing Roth conversions now and paying the (you hope) low taxes now instead of the (you fear) mongo-high taxes later.
All that matters as to SS, taxable pensions, or other taxable income is that the more of that income there is, the higher the average taxes you’ll pay now to do X dollars of Roth conversion. Which means the less you’ll be able to convert profitably unless a) your opinion of future tax rates is lots higher than today’s rates, and b) it turns out you were right.
Clear as mud yet? If not I’ll stir the water some more in a couple hours. Gotta run. Cheers!
I think your assumption that a reversion to the prior tax regime constitutes “nothing happening” in Congress is dubious. It’s impossible for literally nothing to happen - the debt ceiling must raised periodically, some kind of budget must agreed. If reaching something mutually acceptable in Congress is so fraught that the default starting position for negotiation is nothing changing, I think that’s more likely to mean that the current tax regime is extended, not that we must revert to the previous one on a technicality.
Wow, that was a thorough write up. Thank you so much!
So, yes, that’s what I was expecting - a matter of headroom to do Roth conversions over time without paying excess taxes. I just didn’t know if there was some other factor re SS that I hadn’t considered.
In my case, I’m a single guy and expect to stay that way tax-wise. I’ve got $962k to convert and I think 13 years to do it, so taking SS early I still have some headroom re taxes, but I’ll bring it up with my CFP when we talk in a couple of weeks.
Thanks again.
I’ll stand by that statement, because it was followed by “New legislation would be required to enact new tax cuts.” Obviously, Congress will have to pass legislation, the treasury will have to borrow money etc. I didn’t say the entire government would continue in automatic.
What I was clearly stating was the fact that these cuts sunset by law. And if Congress doesn’t take further actions vis-a-vis the tax brackets and percentages they will automatically revert back to inflated 2017 levels.
I wasn’t disputing that. The point is that since new legislation is certainly required to prevent default or government shutdown, it is not reasonable to assume that there will be no new legislation at all and that the default path is whatever is written into existing legislation. What it’s reasonable to expect is that if Congress is at a standoff, the default negotiating position will be that nothing changes in the tax regime, not that no new legislation is passed.
There is one factor that is specific to SS. Namely that the taxability of your SS benefit depends on your other taxable income.
In a nutshell SS benefits are either completely untaxed, or 50% of them are taxed as ordinary income, or 85% of them are taxed as ordinary income. All depending on your “combined income” which is a particular not-very-hard calculation. A particular gotcha with this system is that there is no phase-in or transition zone. for single people the 50% taxability range for 2024 extends from $25K to $34K. With no SS taxability below $25K, and 85% taxability above 34K.
So if your “combined income” is $24,999, your SS benefits aren’t taxable. If your "combined income is $25,001, you’ll pay ordinary income taxes on 50% of your SS benefits. Which might be an extra $1,000 in taxes for $2 in extra income. Oops. If a voluntary Roth conversion moved you across one of those thresholds that might be a goof.
See here for more details: Is Social Security Taxable? (2023 & 2024 Update) | SmartAsset
This is why I went from doing my own investments and taxes before retirement to having a financial planner afterwards. It’s way too tricky now.
OK, I’d vaguely heard of that, thanks for spelling it out.
If I take SS this year, my benefits will be $32,424. I have stuff making dividends etc, so there’s no way in hell I can avoid being taxed on 85% of my benefits if the dividing line is just $1600 higher, so this is not a factor for me. Thanks again for all the thoughtful posts!
@squeegee: I’m in your same boat. Due to first the mongo pre-RMD conversions I / we need and then due to my / our mongo SSs, my/our SS will always be taxed at 85% so I don’t much care about managing that factor. Nice to have one complicator off the table, but shame it’s pulled off the table in the most expensive manner possible.
Between ordinary income tax brackets, capital gains tax brackets, SS taxability brackets, IRMAA brackets, and the NIT surtax, there are actually about 25 tax brackets. Some of which bite real hard if you cross one unwittingly. Others of which are pretty soft-edged or minor.
But merely hiring a pro is no guarantee that they know how to optimize against all this stuff. Many CFPs suck at tax and most tax folks suck at investing.
The Wealth Management group that I use has CPAs and CFPs in the same office. One of each is assigned to me and they work closely together. I meet with both of them together in our annual meeting. I have enough invested that I get the taxes done for no additional charge.
So I talked to my CFP today, and we are going to delay taking SS this year when I’m 62 and eligible until later, exactly to have more headroom for Roth conversions. Instead we turned on some incoming generating mechanisms that were already set up.